Russia has 28 different Special Economic Zones, but it’s still waiting for a major success story on the scale of the SEZ in Shenzhen, China. So what should Russia do next?

A worker in the welding shop of the Ford Sollers plant located in the Alabuga Special Economic Zone. Photo: RIA Novosti

As Russia adapts to life under sanctions, it’s also leading to a re-thinking of how different strategic initiatives – such as the one on Special Economic Zones (SEZs) – can be used to jumpstart economic growth in the country. Last June, the Kremlin called the initiative on Special Economic Zones in Russia “inefficient.” That’s because recent initiatives in this area have proven to be expensive and haven’t provided the expected return on investment.

Special Economic Zones are a controversial subject: for each successful example, there are a myriad of failed projects. Today there are more than 4,500 SEZs around the world and the number keeps growing.

Russia’s SEZ initiatives in recent years have focused on attracting foreign investment to several regions of Russia. Today, there are 28 zones in Russia, and this is actually the first clue why the execution of this kind of project has not been as successful as originally hoped. Without any clear Russian success story, the creation of 28 parallel initiatives has proven to be costly and ineffective.

The first thing that the Russian government should do is to conduct more comprehensive research in one or, at maximum, a couple of zones, to spur the development of a deeper strategy. Offering fiscal incentives without creating the environment for business around these zones is a decisive factor that contributes to failure.

The most successful zones understood this constraint, and before implementing the SEZ, they planned the local infrastructure and carried out other initiatives. Simply replicating successful models from other nations will not be enough for Russia - it is necessary to adapt good models, while taking into account the characteristics of the local economy.

Specialists often refer to the Shenzhen experience in China as a success story. In the 1980s, an SEZ initiative transformed the city into an economic exporting powerhouse. Its model proved successful because for every foreign investor taking advantage of the local tax incentives and built-to-export infrastructure, there were Chinese companies providing intermediate services and goods. This is what economists call “backward and forward” links, making the SEZ not a stand-alone initiative but, rather, an enabler of the region’s industrialization.

Investing, first, in the creation of a local network of entrepreneurs and fostering the growth of new mid-sized companies that could become suppliers of larger foreign companies, is an important step. Entrepreneurs and small-to-midsize enterprises (SMEs) need to have access to cheaper credit than is typically available through commercial banks or other lending institutions. 

Local infrastructure is another factor that should be evaluated and improved. Large manufacturing production centers need large outflow corridors, easy access to ports, logistics hubs and/or consumer markets. Both manufacturing and services companies need access to a surplus workforce, often specialized. There is a need for a coordinated initiative between the SEZ and local universities, in order to buildup the necessary knowledge to maintain the skills and capabilities of the workforce.

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The rule of law and ease of doing business is often an overlooked factor for the success of businesses in countries, and it is not an exception in the case of the SEZs. According to The Economist, 61 of the 139 approved SEZs in the Indian state of Maharashtra failed because of capricious policymaking, a murky screening process and concern over economic prospects. And a high percentage of SEZs in Senegal flopped because of a combination of excessive bureaucracy, high electricity costs and distance from a good port.

Another article from the Asian Development Bank echoes this point: “Putting in place independent governing authorities and enabling legal frameworks are key ingredients that can help SEZs increase the chances of success. Among the countries in Asia with SEZs, those with independent SEZ authorities increase exports by 27 percent compared to those without.”

The same article comments, as well, on the importance of the clear link between the SEZ and the country’s economic development strategy.

SEZs can be a tool for economic development in Russia if they can be inserted into a broader strategy and approach. They can be the justification for the introduction of necessary reforms in the economy as well as enable investments in the areas that will not just benefit the SEZ, but also the entire surrounding areas.

The Kremlin needs to create a SEZ strategy in the “Russian way,” understanding the constraints of its own economy and creating the fertile soil not just for the zones themselves but also for entrepreneurship in Russia as a whole. And they should be created with the understanding that this kind of strategy initially will create small results in the short-term. However, each SEZ will prepare the economy for more sustainable growth and greater results over the long run.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.